Brinkmanship by GAIL: Opponents are more powerful than itself

The fact that GAIL is seeking renegotiations of the long term Indian LNG projects supply terms with its US and Australian suppliers is something to watch out for. All suppliers are likely to resist a price renegotiation. A signed deal is held sacrosanct and the covenants can only be changed mutually. If like GAIL, all buyers were to seek renegotiation of signed contracts, all hell will break lose in the LNG market.

GAIL’s ability to maneuver a price revision will depend entirely on whether it can garner support from other off takers from the terminals in which the gas major as supply agreements. Or it may well risk becoming a pariah. The Americans are unlikely to take kindly to GAIL’s plea as they have back-to-back arrangements with their financiers against gas offtake and fixed price elements of their contracts with buyers and any price revision will upset this fragile equilibrium.

According to reports, GAIL wants the fixed portion of their US cargoes to lowered to around USD 7-8 per mmBtu as against the present USD 9.7. This is far too deep a price cut for any supplier to agree to. If negotiations fail, it will end up in ugly litigation, which will be a big loss of credibility for GAIL.

GAIL will have more leverage in getting a discount from Gorgon LNG, as the price of gas is indexed at 14.5 per cent of prevailing oil rate, which is arguably very high and there is scope to bring it down.
Can GAIL walk away from these deals?
The pros of cons of reneging on the deals may have occurred to GAIL. Weighed against punishing litigation is the prospect of containing a splurge of red ink on its balance sheet from next year onwards. Overall, GAIL will be playing a dangerous game against opponents which are more powerful than itself

Is it failing to cope?

The International Energy Agency, which in 2011 predicted a ‘golden age of gas’, now sees a more tepid picture. Demand for gas is not going up in the segments in which it was meant to in the manner thought earlier. Suppliers are now banking on new countries to push demand whereas, earlier, a more intensive use of gas was meant to stir up demand in countries where gas usage was already prevalent.

The fundamental problem with GAIL is that it did not adapt to the changing environment. The new LNG world demanded a diversity of approaches and business models and GAIL failed to develop them while other LNG players, such as Shell and BP, did. Diverse portfolios — whether as trader or buyer — were the need of the hour to manage price risks.

GAIL failed on this count, as its only option was to get the LNG to India.
What GAIL needed to do was to staff up its risk and economic forecasting departments, as others had done as they ventured beyond the traditional way of doing the LNG business. From the old model of arbitraging cheap gas, the new world required participants to be market-finders and market-makers.

The best companies were seizing opportunities proactively whereas GAILwas not.
Trends show LNG players — both traditional giants, and new entrants from state concerns to small entrepreneurial firms — not just adapting to a changing reality, but creating their future.
GAIL is a long way behind.